An Analytical Study on Impact of Credit Rating
Agencies in India’s Development 1G. Sunitha and
2Rinku Sanjeev
1K.L.U. Business School, K L E F (Deemed to be University),
Greenfields, Vaddeswaram, Guntur, Andhra Pradesh, India.
[email protected] 2K.L.U. Business School, K L E F (Deemed to be University),
Greenfields, Vaddeswaram, Guntur, Andhra Pradesh, India.
Abstract Credit rating agencies (CRAs) plays a crucial role in financial markets
for lenders, investors and issuers in reducing information asymmetry
between different parties. Credit rating helps us to know about the credit
capability of individuals in a country. When all the investors are positively
rated, then there will be an increase in new startups. Gradually income of
the country increases, Employment opportunities expands and Poverty
ranks less. When there is development in all the sectors then the GDP
increases and country develops. The paper clearly explains the part played
by credit rating agencies in the development of a country either directly or
indirectly. The objective is to study about the importance of credit rating
for a country to develop. Analytical research as well as descriptive type of
research is used for the study. Secondary as well as primary data has been
gathered for the study. The sources for the data are through the websites of
the rating agencies, journals, newspapers and banks. Banks helps in
knowing the investment status of the country. The study briefly explains
the steps which lead to country’s development. This helps in knowing the
economies standard of living and development. The study describes,
considering what points and how a country gets developed. The study
discussed the objectives of research, hypothesis formulated, definition of
the basic terms, assumptions and limitations. The study helps us to know
the financial position of the country and part played by different sectors in
the progress of the nation.
Key Words:Credit rating, Credit rating agencies, banks, services, GDP,
development.
International Journal of Pure and Applied MathematicsVolume 119 No. 15 2018, 1281-1294ISSN: 1314-3395 (on-line version)url: http://www.acadpubl.eu/hub/Special Issue http://www.acadpubl.eu/hub/
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1. Introduction
Service sector is an important sectors that majorly contributing to country’s
development. Credit rating comes under financial services, as it provides
financial security with their ratings. Presently, credit rating represents one of the
most significant financial issues due to the recent economic crises. The role and
importance of credit rating agencies have increased in the recent years.
Definition Credit Rating
Credit rating refers to knowing the credit assess ability of customers that means
knowing the credit repayment history of the customer. Credit rating is used by
all the customers who would like to seek loan facilities.
Credit Rating Agencies
Credit rating constitutes an opinion of a rating agency that evaluates the basic
credit strength of any customer and his capability to fully and on time meet his
debt commitments. Credit Rating specifies the credit praiseworthiness of the
borrowers and the possibility of the borrowers will pay back the interest and
principal on payable dates.
Origin of Credit Rating Agencies
The journey of Credit Rating Agency started from 1841 by Lewis Tappan in
New York City. It was then gained by Robert Dun, who published its first
ratings guide in 1859. Another early agency, John Bradstreet, started in 1849
and published a ratings guide in 1857.
Credit rating agencies took birth in the United States in the early 1900s, when
ratings began to be practical to securities, exclusively those related to the
railroad bond market. In the United States, the construction of wide-ranging
railroad systems had lead to the enlargement of corporate bond issues to finance
them, and consequently a bond market several times superior than in other
countries. Following the 1907 financial crisis, demand started increasing for the
autonomous market information, in particular for independent analyses of bond
creditworthiness. In 1909, financial analyst John Moody issued a publication
focused solely on railroad bonds. His ratings are the first one to be published
extensively in an easy to get to format, and in fact his company was the first one
to charge subscription fees to investors.
Objectives of the Study The main objective of the study is to render a certainly friendly third
party opinion on the potentiality and creditworthiness of the customers.
To create knowledge amongst customers about the extent to which their
payment history affects their credit score.
To know how Credit Rating helps in a country’s development
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To study the main part played by credit rating agencies in developing a
country.
To provide them a chance to improve & increase their organizational
strengths, opportunities and Credit worthiness, by which they can outpour
credit at a very cheaper rates and on easy ways.
Need and Importance of the Study Credit Rating Agencies play a major role in country’s overall
development.
Credit rating agencies primary role is to reduce information asymmetry in
credit markets by providing customers an opinion on the capability.
Banks need to select best credit rating agency to get accurate information
about customers.
It also helps the distributers of the debt instruments to price their issues in
the approved manner and to reach out to innovative investors.
It helps investors in launching new business which in turn develops
country’s income.
The main importance of the study is to know the roles played by credit
rating agencies for a country to develop in all the sectors.
2. Scope of the Study
The scope explains the theoretical aspects of credit rating in developing a
country. The study has been carried on the efficiency of credit rating agencies.
The study considered the steps which lead to country’s development in which
GDP has been considered as a symbol of development. GDP shows the
development of any country.
3. Research Methodology
Both analytical research and descriptive research were used in analyzing the
objective of the study. Analytical research represents the investigative and
organized study using the facts which are already available to come to a
conclusion. Descriptive research represents expressive and graphical
representation of the data for analyzing and representing the result for the study.
4. Sources of Data
Primary data: Data gathered by personal communications with the people of
credit rating agencies.
Secondary data: Data from websites, newspapers, journals, books, credit rating
agencies is used for the study.
Tools and Techniques: Tools and techniques used for the study are tables, line
graphs and pie charts.
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Hypothesis H0: There is no significant influence of credit rating agencies on service
sector GDP.
H1: There is significant influence of credit rating agencies on service
sector GDP.
H0: There is no significant influence of credit rating agencies in India’s
development.
H1: There is significant influence of credit rating agencies in India’s
development
Service sector GDP represents the contributions of Service sector towards GDP.
As Credit Rating is a part of financial services, so it has been considered for the
study.
5. Review of Literature
Frank Partnoy (2017) this article discusses about three problems which are
been faced by credit rating agencies because of congress government. The
author proposed suggestions for these problems in this article. Author strongly
put pressure on the ongoing problem faced by both the parties i.e., rating
agencies and investors. The theme of credit rating is missing because of the
methodologies which are followed by the rating agencies. He even pointed out
the problem of unwarranted and mechanistic reliance with credit ratings. He
observed the lack of oversight of credit rating agencies and suggested some
regulatory reforms for this problem. He addressed about the methodologies and
different types of risks of corporate.
Patrick Bolton, Xavier Freixas and Joel Shapiro (2012) Authors talks about
the competition among credit rating agencies which was expected to reduce the
efficiency of market with help of a model. They explained about the features of
credit rating agencies in brief. Author’s organized the study in the form of
sections explaining the comparison and expansion of credit rating agencies.
They also made some assumptions indicating about the information on
investment. They explained the study by examining the game with monopoly
credit rating agencies. They explained the competition among credit rating
agencies and their empirical implications.
Timothy E. Lynch (2009) Author specified the fundamentals of credit rating
agencies and the important role played by credit rating agencies for the
information flow for investment. Author evaluated the role of credit rating
agencies in the capital market and investment policy. He explained about the
usage of credit rating information by private contracting parties. He even
specified about the problematic issues which are been presented by credit rating
agencies. He argued about the integrity defences of credit rating agencies. There
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are many problems with the current regulatory environment which are evaluated
in the study.
Finally author has highlighted the significance of the credit rating industry in
capital market and the problems faced in the credit rating industry under the
current regulatory regime. He even brought to light the problems with the
issuer- pays conflict of interest.
Abdullah Ash-shu’ayree Al-khawaldeh (2013) Authors reviewed many
papers and evaluated the hypothesis by using the statistical tools like regression
analysis. According to the study there is no empirical evidence of whether it is
based on bivariate or multivariate analysis, which supported the relationship
between the Jordanian listed company’s capital intensity and credit rating. The
study identified the fixed assets level as relatively small. Authors concluded the
research confirming the different techniques using credit rating internal data
models for the analysis which results that some variable have a significant
impact on credit ratings. The results of the study specifies even the size and
growth potential are associated with positively strongly credit ratings.
Omaima. G. Hassan and Ray Barrell (2013) Author analysis the study and
examines the problem of, to what extent banks ratings reflect banks and the
characteristics explains the accounting information to determine the problem.
Author explained the study using descriptive research by taking the samples of
US and UK. Statistical tools like correlation matrix and regression results are
used to evaluate the study. The results revealed the performance of the model
which helped 74% to 78% of banks in assigning correct credit ratings. There
was a difference of assigning ratings to the banks, as highest rated banks and
lowest rated banks.
Marwan Elkhoury (2008); Author discussed about the information gap in the
international financial system. Using qualitative and quantitative methods as
procedures and methods for evaluation. Author elaborated the methodology
profile of Standard and Poor. The determinants of credit ratings explain both the
mature and emerging markets. Author discussed about the two other various
independently. They are increased in international interest rates and the exports
structure. He discussed about the shortcomings which arise out of regulatory
initiative. Credit rating agencies analyze many factors for assigning rating, that
factors have been discussed in the study.
The review of literature represents the author’s opinion about the credit rating
agencies. This review helped my study to understand the methodologies which
are followed by credit rating agencies and the problems which are been
discussed in the review helped me to study further.
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Benefits of Credit Rating Agencies
Credit ratings are a considerable gadget for borrowers to get admission to loans
and debt. When investors have good credit history then their credit rating score
will have no objection. Credit ratings help investors to effortlessly borrow
money from financial institutions or public debt markets. At customer level
generally banks, base the terms of a loan as a main task of the credit rating, so
with this the better the credit score, the better the terms of the loan typically are.
If the credit score is poor, the bank may even reject the loan. As this is the base
for granting of loans. When loans are approved for investors then they start new
business by which employment increases, increasing incomes of individuals.
Growth is possible when all the sectors develop. When one sector is developed
the result will play a part for the development of another sector.
Assuming the Steps which Lead to Country’s Development Positive credit history
Credit rating agencies positive credit score
Issue of loans
Investment into new business
Increase employment opportunities
Income increases
Better standard of living
Demands more products
Leads to increase in supply levels
Prices decreases
Inflation increases
Effects GDP
Country develops
Figure representing the steps which lead to country’s development:
The figure represents the steps which help in country’s development and how
each sector is depending on another. When one sector is developed the result
will help another sector to develop which leads to total country’s development.
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Data Analysis and Interpretation
Table 1: Tabular Representation of GDP of India from 1980- 1990
Graph 1: Graphical Representation of GDP of India from 1980-1990
Interpretation
It is clearly observed in the graph that there are fluctuations in the GDP,
whatever the reason maybe, whether the decrease may be due to other sectors.
As compared from 1980-1990 the GDP has very little increased, showing a
positive indication of development of economy.
Table 2: Tabular Representation of GDP of India from 1991- 2000
Graph 2: Graphical Representation of India’s GDP from 1991-2000
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Interpretation
We can clearly identify the huge changes in the GDP. At a certain point it even
reached 8 but gradually decreased in 2000. But comparing the years 1991-2000
there is a slight increase in the GDP. But many changes took place in between
these ten years.
Table 3: Tabular Representation of GDP of India from 2001-2010
Graph 3: Graphical Representation of India’s GDP from 2001- 2010
Interpretation
Even in this graph there is bit more changes in the GDP. At a certain stage a
huge rate has been noticed that is 9.8 in 2007 and slowly decreased and then
increased and reached 10 in 2010 which is a positive indication of country’s
development.
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Table 4: Tabular Representation of GDP of India from 2011-2017
Graph 4: Graphical Representation of GDP of India from 2011-2017
Interpretation
There are fluctuations which took place in these years which started at 6.6 in
2011 and at a certain year it reached 7.9 in 2015 and then decreased to 6.7 in
2017. There is a slight change in GDP but this is also showing a positive hope
of GDP to increase in upcoming years.
There are Different Sectors which Majorly Contribute to GDP. They are: Agriculture sector
Industrial sector
Service sector
Contribution of Different Sectors to GDP
Table 5: Tabular Representation of Different Sectors Contribution towards GDP in
1951-52
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Graph 5: Graphical Representation of Different Sectors Contribution towards
GDP in 1951-52
Interpretation
In 1950-51 the priority was given much to agriculture sector as it is the main
occupation of our country, whereas service sector contributes only 34% towards
GDP. It may be due to lack of knowledge about modern technology and usage
of traditional methods and techniques.
Table 6: Tabular representation of different sectors contribution to GDP in 2016-17:
Graph 6: Graphical Representation of Different Sectors Contribution to
GDP in 2016-17
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Interpretation
We can see a drastic change in service sector contribution; it is almost 54% of
the total GDP. There are many reasons for the expansion. They are discussed in
brief in this paper. More than half of the GDP share is from service sector. This
shows the development of the country.
Roles of Credit Rating Agencies towards Country’s Development Credit rating agencies estimate the relative credit risk of specific debt
securities or structured finance instruments and borrowing entities.
The creditworthiness of governments and their securities.
Serves as information intermediaries connecting banks and customers.
CRAs tentatively lessen information costs.
Increase the collection of praiseworthy or prospective borrowers.
Promote liquid markets.
These functions may add to the contribution of accessible risk capital in
the market and support economic growth.
General Factors which Effect Credit Scoring The agency takes into account the individuals past credit history of
borrowing and repayment of debts. If any payments are missed or
defaults on loans impact the ratings negatively.
The agency also observes the businesses potential economic capability. If
the economic potential seems bright, the credit score tends to be higher; if
the borrower does not have a positive economic outlook, the credit rating
will decrease.
The credit rating is carried to individuals by source of a numerical credit
score that is maintained by Equifax, Experian, and other credit-reporting
agencies. A positive credit score ranging from 700-900 specifies a
stronger credit summary and will generally result in lower interest rates
exciting the lenders.
There are a many factors that are taken into consideration for estimating
an individual's credit score including payment history, amounts to be
repaid, and length of credit history, new credit, and types of credit. Some
of these factors have superior weight than others. Details on each credit
issue can be found in a credit report that which explains about a credit
score.
Limitations of the Study The prevailing manual credit risk management systems are quite
expensive and very difficult to maintain.
The cost that is involved in maintaining the qualified, experienced and
trained credit rating executives is very high.
It is not possible for different types of investors to come to a common
ending as to the qualified quality of the instrument. Moreover they do not
ensure the requirement skills of credit estimation.
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As the data used for the study is secondary data. It may be lacking in
accuracy, or they may not be completely latest or reliable.
The study considered only GDP for analyzing country’s development.
Hypothesis
Evaluation of Hypothesis The analysis clearly gives information that there is significant influence
of credit rating agencies on service sector GDP
There is significant influence of credit rating agencies in India’s
development which has been indirectly explained with the figures and in
data analysis.
Development is not directly possible in service sector; there are many
points to be considered which the study evaluated in brief.
6. Conclusion
When the credit history of the investors is good then their credit score
would be better and positive. Therefore getting loans becomes very easy.
When loans are approved investors can invest in different businesses
increasing employment.
The development of a country depends on GDP of that country.
As per the study the GDP shows a positive increase which represents the
development of the country.
If all the sectors develop then the development of the country is very
easy.
References
[1] Ash-shu A., Determinants and Impacts of Internal Credit Rating, International Journal of Financial Research 4(1) (2013), 120-131.
[2] Bai L., On regulating conflicts of interest in the credit rating industry, NYUJ Legis. & Pub. Pol'y 13 (2010).
[3] Evans C., What Makes You So Special?: Ending the Credit Rating Agencies, Special Status and Access to Confidential Information, Val. U. L. Rev. 46 (2011).
[4] Hill C.A., Why Did Rating Agencies Do Such a Bad Job Rating Subprime Securities?, University of Pittsburgh Law Review 71 (2010).
[5] Partnoy F., what’s (still) wrong with credit ratings?, Washington law review 92 (2017).
[6] Elkhoury M., Credit rating agencies and their potential impact on developing countries, Discussion paper no.186 (2008).
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[7] Hassan O.G., Barrell R., Accounting for the determinants of banks’ credit ratings, Economics and finance working paper series (2013).
[8] Bolton P., Freixas X., Shapiro J., The credit ratings game, The Journal of Finance 67(1) (2012), 85-111.
[9] Cantor R., Packer F., Differences of opinion and selection bias in the credit rating industry, Journal of banking and finance 21(10) (1997).
[10] Lynch T.E., Deeply Persistently Conflicted: Credit Rating Agencies in the Current Regulatory Environment, Case Western Reserve Law Review 59 (2009).
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